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Original scientific paper
UDC 331.5:65.011.8/(497.12)
Labour market reforms in the context of political
power theory: The case of Slovenia*
Mitja Čok1, Polona Domadenik2, Tjaša Redek3, Miroslav Verbič4
Abstract
The rigidity of labour market has several important negative economic consequences: it stifles job creation, increases discrimination of those that it is actually
aimed at protecting (young, women and the low-skilled), hurts the unemployed,
slows down economic restructuring and damages its global competitiveness. But
reforms are slow and often marked with disputes among partners in the collective
bargaining process. Afraid of social security loss, unions usually oppose the reform, while governments usually give in to the union pressures and negative image
of reform consequences created by unions and assisted by media. The characteristics of the labour market and labour market reform with respect to bargaining
among power groups are examined both theoretically and empirically in the case
of Slovenia.
Key words: labour market flexibility, re-election process, reforms, Slovenia
JEL classification: C70, D02, J08
*
1
2
3
4
Received: 30-11-2008; accepted: 19-06-2009
Assistant Professor, University of Ljubljana, Faculty of Economics, Kardeljeva ploščad 17,
1000 Ljubljana, Slovenia. Scientific affiliation: tax systems, fiscal policy and finance. Phone:
+386 (1) 5892-741. E-mail: [email protected].
Assistant Professor, University of Ljubljana, Faculty of Economics, Kardeljeva ploščad 17,
1000 Ljubljana, Slovenia. Scientific affiliation: microeconomic theory, transition economics,
environmental economics, labour economics and feminist economics. Phone: +386 (1) 5892498. E-mail: [email protected].
Assistant Professor, University of Ljubljana, Faculty of Economics, Kardeljeva ploščad 17, 1000
Ljubljana, Slovenia. Scientific affiliation: macroeconomic theory, theory of economic growth and
development, with the focus on environmental and institutional issues and feminist economics.
Phone: +386 (1) 5892-488. E-mail: [email protected] (corresponding author).
Research Fellow, Institute for Economic Research, Kardeljeva ploščad 17, 1109 Ljubljana, Slovenia. Scientific affiliation: tax systems, fiscal policy, monetary economics and econometrics.
Phone: +386 1 530-3842. E-mail: [email protected]
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1. Introduction
Institutional framework has been proven to be an important factor of economic
growth and development (Barro, 1991, Berg et al., 1999, Acemoglu, 2005). Labour
markets have been widely discussed in the past few years as one of the primary
factors of lower competitiveness and sluggish responsiveness to economic changes
in many European economies. But European welfare state tradition and worker
protection are strong and therefore opposition towards reforms that might endanger
the acquired level of rights can be expected to be fierce. The theoretical literature on
the labour market relations has shown that the free-labour market relationship is not
efficient. In response to the perceived unfairness and inefficiency of the free market
employment relationship, nearly every state intervenes to protect the workers in this
relationship (Becker and Casey, 2003; Stigler, 1971). Several negative side effects
of labour market regulation have been identified, from less intense job creation to
even more obvious discrimination. These negative effects of rigid labour market
regulation, which is characterized by difficult process of hiring and firing workers
and consequently less intense job creation, working time regulation and high costs
associated with these factors, have lead to intense debates over labour market
reform in numerous European economies.
Despite the obvious need to introduce reforms to at least some aspects of the labour
market, the reforms are being delayed or not implemented. One of the key reasons
is the political element. The governments, afraid of losing their positions in the
following elections, are reluctant to implement reforms that might be perceived
by wider public as harmful to the welfare of the masses. Namely, too often the
reforms that could in the middle and longer run be beneficial to the wider public5,
are being interpreted by the unions and the media as negative and only the potential
negative side-affects are publicized strongly. Unions often fiercely defend their
adopted rights due potential negative short term consequences for some groups in
the labour market and the fear of social security loss6. The delays and decisions not
to implement unpopular reforms will in the longer run stifle economic growth and
consequently also job creation, as the competitiveness of an economy declines.
This paper explains labour regulation and propensity to reforms through the context
of political power theory and it contributes to the existing literature in several ways.
5
6
For example, introducing flexicurity elements has been proven to help Danish competitiveness and
growth and the model is being mentioned as a solution to enhancing EU growth (see also Madsen
(2006) and European Commission (2006)). Also simplified flat tax system has been argued to help
the development in the Slovak republic, especially by attracting FDI (Goliaš and Kičina, 2005). But
reforms in similar direction have been fought by the unions in Slovenia due to their potential negative
impacts, especially in the shorter run.
In Germany changes to unemployment benefits were in debates for 11 years. The Dutch government
reached agreement on reforms with labour unions and business organisations in 1982, only after 9
years of failed negotiations (Doing Business, 2004).
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First, it links labour market regulations with political power theory in a systematic,
game theory approach. Second, the game theory approach is justified by country
case study, Slovenia, a successful transition economy with rigid labour market
regulations. The theoretical model, showing how the structure of the elective
body affects the reform process, is being examined first by the public opinion
polls data to justify the decision for ‘not reforming’ by the strength of the public
opinion. Then the theoretical model is implemented and examined empirically
in the general equilibrium framework (Bayar et al., 2006; Majcen et al., 2009).
Our main hypothesis is that in the context of political power theory the reforms’
implementation depends on the opinions of low productivity workers about potential
benefits of the reform. We investigate, whether the initial desire of the government
to reform the labour market towards greater flexibility was actually implemented
or whether, as suspected, the actually implemented reform was the ‘anti-reform’,
improving the immediate position of the majority of the elective body.
The article is structured as follows. Section 2 outlines the theories of employment
regulation, followed by the development of the theoretical model of the reform
process in Section 3. Section 4 portrays the case of Slovene transition and labour
market development, where the (un)success of Slovene reforms, its implications
and possible development are examined empirically. The final section concludes
our work with the main findings.
2. Dimensions of labour market regulation
To correct for the imperfections in the labour market, countries have adopted complex
systems of laws and institutions encompassed by employment law, collective relations
law, and social security law7. According to the literature (Lazear, 1990; Bertola et al.,
2000; Deakin, 2001), government intervention in the labour markets can take four
forms. First, government forbids discrimination in the labour market and endows the
workers with some “basic rights” in the on-going employment relationship (such as
maternity leaves or the minimum wage). Second, governments regulate employment
relationship, for example by restricting the range of feasible contracts and rising costs
of both laying off workers and overtime work. Third, in response to the power of
employers against workers, governments empower labour unions to represent workers
collectively, and protect particular union strategies in negotiations with employers.
Finally, governments themselves provide social insurance against unemployment, old
age, disability, sickness or death.
7
Employment laws govern the individual employment contract (Botero et al., 2004). Collective or
industrial relations laws regulate the bargaining, adoption and enforcement of collective agreements,
the organisation of trade unions, and the industrial action by workers and employers. Social security
laws govern the social response to needs and conditions that have a significant impact on the quality
of life (old age, disability, death, sickness and unemployment).
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In the literature there are three major theories of institutional choice that explain
government interventions; the efficiency theory, the political power theory, and
the legal theory. The foundation of the first theory was set by Demsetz (1967) and
North (1981), emphasizing that the choice of institutions is dictated by efficiency
consideration in order to maximize social welfare. According to Glaeser et al.
(2003), countries choose heavier intervention when market failures are severe
(employer abuse of employees is greater in the market), and lighter intervention
when distortion associated with government interference become more severe. The
efficiency theory is too broad and as such is difficult to reject.
The second theory, by far, the leading explanation of labour regulation, is based on
political power consideration implying that labour regulations are more protective
when leftist governments are in power (Saint-Paul, 2000). Such a protection can
restore efficiency if workers are abused in a free market, or it can lower efficiency if
government intervention leads to expropriation of capital by labour. Political power
theories can be assessed in two ways. The first holds that the principal mode of
political decision making is elections, and that parties that win shape the laws. The
second, as described by Becker (1983) and Botero et al. (2004), holds that laws
are shaped by the influence of interest groups, especially trade unions, and should
therefore be more extensive when the unions are more powerful, regardless of
which government is in charge.
The third theory is legal theory that has received considerable attention in the
discussion of institutional evolution (North, 1981). This theory emphasizes the
evolution of the two very distinct legal traditions in Western Europe from 12th
century on, namely common law and civil law that was outspread to other regions
of the world. Since most of the countries in the world received their basic legal
structures in this involuntary way, these structures are exogenous to their economies8
(Botero et al., 2004).
In order to asses the propensity to reform a game theory model in the context of
political power theory is presented. Growing literature (cf. Persson and Tabellini,
2000; Acemoglu and Robinson, 2005) investigates the importance of political
process and vested interests for the propensity to reform. The interaction between
interests for re-election, power of unions and role of the media crucially impact the
possibility of implementation of reform.
8
Common law emerged in England and is characterised by the importance of decision making by
juries, independent judges and the emphasis on judicial discretion as opposed to codes. From England, common law was transplanted to its colonies, including Ireland, US, Canada, Australia and
other countries. Civil law evolved from Roman law in Western Europe though middle ages, and was
incorporate into civil codes in France and German in the 19the century. Civil law is characterised by
less independent judiciaries, the relative unimportance of juries, and a greater role of both substantive
and procedural.
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3. Reform process in the labour market: the theoretical model
Despite the clear indication by theoretical and practical experiences that rigid
regulation aiming at protection is often harmful (cf. Botero et al., 2004; Bolaky and
Freund, 2004; Domadenik, 2007), the reform process towards greater flexibility
is very slow. Usually one of the key reasons is the political consequences of an
unpopular reform. Despite the clear understanding among economists and even
politicians that such a labour market reform can be beneficial to the society as a
whole in the long run, the reforms are often not undertaken or at least delayed till the
next election, while only necessary patch work takes place9 (cf. Acemoglu, 2003).
We develop a theoretical model based on game-theory approach and bargaining
among power groups in the labour market in order to explain the propensity to
reform and use the model as a theoretical background for the analysis of the reform
process in Slovenia.
3.1. Outline of the model
The model will be based on the intuitive model presented by Fernandez and Rodrik
(1991) and Acemoglu (2003). We will extend it into two period model with several
interest groups. We start with the simple labour market approach to population
groups (Figure 1). The size of the population is normalized to 1. Respective
shares of each group within the population are denoted in Figure 1 (in brackets).
Total population is divided into active (share α) and non-active (share 1 – α). The
active are further divided into employed (share β in total active population) and
unemployed (share 1 – β). The employed are further divided into high productivity
workers (share of them in total employed is λ) and low productivity workers (share
1 – λ). We additionally assume that the model is a short term model, therefore there
is no need for a balanced public finances budget10.
9
10
Acemoglu (2003) lists several reasons for such behaviour: (1) voters might be myopic and do not see
the potential benefits of the reform; (2) the reform might be socially beneficial to future generations,
but because it is not to present generations, there will be a lack of support for it; (3) there can also
be several veto players present in forms of lobbies or strong social groups that can block the reform;
(4) uncertainty about the cost and benefits to reform might also lead to opposition to reform; and (5)
political losers might also oppose reform for all listed reasons and a threat to loss of power.
In addition, we would like to stress here that the problem is also solved in the empirical model, because it is a computable general equilibrium model (CGE).
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Figure 1: Interest groups in the society
Source: Authors’ presentation
The political reform must be passed in parliament, therefore it needs political
support. But any party, currently in office, will maximize its value function, which
directly depends on the possibility of re-election. The reform will go into public
debate. Unless it received sufficient public pole support, politicians might feel that
passing such an unpopular reform (although necessary in the longer run and also
highly beneficial in the longer run) shall endanger their immediate re-election and
would not pass the reform11.
At the end of current period election takes place again. Economic consequences of
the reform will not be known until the next period, meaning that the politicians will
be very reluctant to pass any reform that does not have sufficient public opinion
support. The reform will be beneficial to all in the longer run (and thus bring
positive consequences to all in the second period), but the positive consequences
for some in the longer run will be lower than for the others, i.e. some will benefit
more than the others. In the current period some groups will benefit from reform,
others will not lose much (i.e. have a slightly lower wage, but keep their jobs), third
might lose a lot (i.e. become unemployed).
11
For more on related issues see also cf. Dur, 1999; Drazen, 2000; Persson and Tabellini, 2000; Castro
and Coen-Pirani, 2001; Acemoglu and Robinson, 2005.
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The main problem in the model is uncertainty. To pass the reform, politicians will
want majority public support for the reform. But the outcome for some groups in
the current period is uncertain and they will thus be reluctant to support the reform.
Therefore, the political outcome will depend mainly on two factors: (1) relative size
of groups who win and lose with the reform, and (2) the expected outcome of every
particular group of voters.
Table 1: Outline of the model
Labour market
reform proposed
Period 1: What the groups already
have
High productivity wH (1 – t) (1 – T)
Low productivity wL (1 + s) (1 – T)
Election
↓
*
Economic consequences
of reform take place
Period 2: What the reform will bring
to the groups
High productivity wH (1 – T1)
Low productivity wL (1 – T1) with
probability p or become unemployed
with probability (1 – p)
Unemployment B1 and higher
probability q1 wAVG
Increased investment, growth and
wage impact
Source: Authors’ calculations
The labour market reform will be directed at increasing the flexibility of the labour
market. This implies mainly lower firing costs, potentially lower benefits, or benefits
for a shorter period of time. The reform will affect different groups differently
(Tables 1 and 2). We assume that the high productivity workers (H) are currently
receiving a wage that is lower than their productivity, because wage regulation
punishes the productive workers at the expense of less productive (e.g. minimum
wages) (Lemieux et al, 2009, Lazear, E. P. (2000)12. We model this by introducing
the ‘rigidity tax’ rate (t) into the model. Because firing costs are high13, firms are
12
13
As an indication of the lack of relationship between wages and productivity growth, the growth rates
of wages in the private and public sector in Slovenia can be used. IMAD (2007) shows the relationship between productivity and wage growth in the public and private sector. Let’s assume that the
productivity growth mainly results from the private sector. Despite fluctuations, there is no indication that the relationship between productivity and wages is straightforward, it is subject to policy
changes and policy goals.
For example Doing business (2009) data shows that the firing costs in Slovenia expressed in terms of
weekly salaries are with 37 weekly wages significantly higher than the OECD average (25,8 weekly
wages) and the regional average (26,3 weekly wages).
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reluctant to dismiss some of low productivity workers (L), or at least significantly
lower their wages due to union pressures. Consequently firms pay lower wages
to higher productivity workers implying that higher productivity workers are
being taxed to subsidy lower productivity workers. High productivity workers are
receiving a wage wH (1 – t), where wH is their productive determined wage, while
t is the ‘rigidity tax’ rate. Low productivity workers are receiving a wage wL (1 +
s), where wL is their productivity wage, while s is the subsidy level existing due to
labour market rigidities. The unemployed are currently receiving benefits B, but they
also have the chance to get a job with probability q. Both groups are also paying a
tax rate T to the government, which is used to finance unemployment benefits B.
Table 2: Results of the model*
Group
Share in society
Gain / loss
Support to reform
λαβ
wH (1 – T) (1 – t)
Yes
Employed
High productivity
Current situation
Post reform
wH (1 – T)
Net gain/loss
wH (1 – T) t
Low productivity
Current situation
(1 – λ) α β
(majority)
wL ( 1 + s) (1 – T)
Post reform
(1 – T) (1 – p) wL + p B
Net gain/loss
p B – wL ( s – s T + T p)
Depends on probabilities, wage
change (s) and tax changes.
Unemployed
Current situation
α (1 – β)
Post reform
(1 – q1) B + q1 wAVG
Net gain/loss
(wAVG – B) (q1 – q0)
Inactive
(1 – α)
Yes
(1 – q0) B + q0 wAVG
On average votes cancel out.
* We assume unchanged tax rate T, unchanged B, and discount rate r = 0.
Source: Authors’ calculations
The business sector will be the main winner of the reform process. It will be able to
adjust their employment levels to economic activity and therefore react quickly to
turbulent economic environment. The greater flexibility will also allow employers
to focus more on the selection and development of those employees who possess
proper skills (Čater and Čater, 2009) instead of losing a lot of time and effort
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thinking how to get rid of poorly performing employees. Data show that elasticity of
demand for labour increases with labour market flexibility (Domadenik et al., 2008).
Firms hire in good times because they know they can fire in bad. Due to the increased
threat of firing, lower productivity workers will be more inclined to accepting a lower
wage than they were before. Therefore the subsidy from higher to lower productivity
workers will be lower. Each group will be paid according to their own productivity.
The reform will also impact the position of unemployed workers and those that might
become unemployed after the reform is implemented. Since firms will be able to fire,
they will no longer be that reluctant to hire and the probability of getting a job will
increase (from q to q1). The government might also decrease unemployment benefits
(B) in order to motivate unemployed to seek for a job.
The group hurt most by the reform is the lower productivity workers’ group (that
might be empirically identified as those with lower level of attained education
or could also be understood or modelled as workers in less propulsive sectors).
Therefore, this group is most likely to be quite opposing to the reform. They are
threatened by unemployment with probability p, potentially lower wages with
probability (1 – p) and potentially lower unemployment benefits (had they become
unemployed). But on the other hand, there is a chance that they also benefit from
reform. If unemployment level lowers, the fund needed for benefits will lower and
thus taxing will decline (T), which means higher wages for all employed. Also, if
lowering benefits (B) is a composite part of reform, this will additionally reduce
fiscal burden and hence taxes.
3.2. Theoretical Results
This very simple exercise has significant results for policy markers. First, we would
like to stress that the implications of the model are valid for an economy not in
distress over a demand or supply shock. In case of crisis and rising unemployment,
all workers have problems finding a job.
Now, let us turn to the results of the model. First of all, it is possible to expect a
wide support for reform from more productive workers [wH (1 – T) t]. This could
also be interpreted as workers in more propulsive sectors.
The unemployed [(wAVG – B) (q1 – q0)] would at first sight also gladly welcome a
reform programme. But a more detailed analysis of the above equation might shed
some doubt on that. First, if benefits are high (which is the case in many countries),
the difference between the expected possible wage and benefits is not high, possibly
it is even negative if all other transfers to unemployed are taken into concern (child
support, subsidized kindergarten, etc.). Second, the public perception of difference
between the possibilities to get a job prior and post reform could be biased. The
reform would increase labour market flexibility and thus elasticity of demand for
labour would increase. But for unemployed to support the reform, the difference
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between the two should be more than marginal. They must believe that it would
be easier to get a job. Therefore it would be good to promote the reform in the
labour market in periods of economic expansion. In such periods expected wages
rise but above all the demand for labour would be on the increase. A good economic
situation in periods when reform is preparing is highly important, possibly much
more than the actual situation just post reform. Of course, the results also depend
on the structure of unemployment. The longer term unemployed, the structurally
unemployed and the elderly will be more likely to support the reform. As the
unemployed are not organised like unions and represent a minority, have low impact
on the public opinion.
The most reluctant to accept the reform will naturally be those workers, whose jobs
might be threatened; [p B – wL (s – s T + T p)]. They will weigh between potential
loss of the job and the expected value of that option, which depends also on the value
of potential benefits and the level of subsidization that is taking place. The lower the
existing benefits or the benefits proposed by the reform, the lower the likelihood for
support. The higher the level of subsidization of lower productivity workers and thus
the higher their wages, the higher the opposition to reform will be.
The political support for reform therefore depends mainly on the opinions of
those less productive workers in the economy14. These also represent the majority
of workers in any economy. Therefore their vote is crucial. In reality, the lower
productivity workers might not all oppose the reform. Even among the lower
productivity workers, the differences are significant. Some of the lower productivity
workers are employed in sector whose future is not threatened and their opposition
to reform thus depends mainly on the level of subsidization from the higher
productivity workers. Those working in less propulsive sectors will be opposing
the change much more fiercely. The bigger the threat of low unemployment benefits
and higher the chance of becoming unemployed, the higher will be their opposition
to the reform. But again, it might be much easier to convince the lower productivity
workers that their jobs are not highly threatened and that in case of unemployment
it will not be hard to find a new job. Relatively generous benefits would serve as
an additional convincing mechanism. Also, the politicians should be aware that the
reform will be much easier to pull through in times of economic expansion, although
the political motivation to change anything when times are good is low. Expansion
means more jobs are being created, wages are growing and the probability to get a
job is much higher.
14
An extension of the model could also consider the importance of the expectation formation across
various population subgroups for the results of the model. The problem of expectation formation
across various population subgroups has been studied by several authors, for example by Malgarini
and Malgani (2008) or Wong and Hardy (2009).
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In this context it is important to mention the power of the media, which channel
the information to the general public and importantly create the public opinion.
The media have a very important impact on politicians and their decisions, because
the media make and annihilate political careers (cf. Besley and Case, 1995; Besley
and Prat, 2006). Therefore good PR and positive public campaign in cases of big
reforms by the government is very important. The government should at all times
stress the positive aspects of the reform and allow a constructive dialog and admit
that there might also be negative consequences for some groups, but that the reform
package has taken care of those by certain measures and programmes. Labour
market reform should be presented to the public as a well thought through package,
which is not aimed solely at making firing easier and lowering benefits but must
also take care of alternative measures to increase employment. The more unionized
the labour market is, the more important is the cooperation with the unions even in
periods when the reform is being prepared. The support of union leaders will in turn
also lead to higher support among workers.
The decision for or against the reform is consequently dependant on numerous
factors, often not related directly to economic problems in the labour market.
Therefore, for successful economic performance it is important to have a government
that is aware of the potential traps of policy making and is able to create good and
credible programmes, which will obtain wider public support. Only so will reforms
actually take place.
4. Transition process and labour market developments
in Slovenia
To illustrate the practical implications of the model, we examine the case of last
major proposed reforms in Slovenia and their fate in the light of the theoretical
setting of the model. In 2004 the newly elected government proposed a series of
ambitious reforms aimed at increasing the competitiveness. One of the more
discussed and problematic reforms were the suggested reforms aimed at increasing
labour market flexibility and the suggested ‘flat tax rate’ (Majcen et al., 2009). These
two were perceived by the general public as reforms that will harm the worker, who
will be now easily sacked, and benefit the rich due to the proposed tax change. We
examine the basic characteristics of the proposed reform in 2006, the pressure of
the public on the government, and the actual outcomes and consequences of the
much less significant changes than originally proposed. But in order to understand
the characteristics of Slovenian legacy and economic history, which also impact the
perception of any reforms, we first provide a brief insight into Slovenian transition
and labour market characteristics.
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4.1. Transition and labour market characteristics in Slovenia
The results of Slovene transition are at first glance very good. Since 1993 Slovenia
has maintained a robust average growth rate of about 4 per cent, and substantially
narrowed the income gap with the European Union (in 2007 GDP per capita in
purchasing power parity amounted to almost 90.6% of EU-27 average). The
successful economic performance resulted mainly from higher productivity,
especially in the export sector (Damijan and Kostevc, 2006), while employment
remained more or less constant. Slovenia has also managed to gradually bring
inflation down to 8.6% already by the end of 1995. Inflation continued to decline to
the level required to accomplish the Maastricht criteria. In 2006 it was 2.8% and in
2007, 3.6% (Statistical Office of the Republic of Slovenia, 2008). In 2007 Slovenia
adopted the euro as the first among transition economies. So far, the transition has
been quite successful. But lack of political desire and opposing interests of power
groups have been delaying several important reforms, including the labour market
reform.
The rate of unemployment has remained relatively low and was declining during
transition mainly due to privatization model, which maintained status quo and
avoided large layoffs at the beginning of the transition. Policymakers avoided
social tensions with high state subsidies to loss making firms in apparel, leather
and many other industries. From 1993 to 2002 the ILO unemployment rate fell by
about one-third, to 6.3%, which is a low unemployment rate compared with other
transition economies and lower than those of many EU members (Riboud et al.,
2002). The unemployment rate varied around 6% till 2007, when it even fell to
4.9%, well below the EU-27 average of 7.1% (Eurostat, 2008). But the low overall
unemployment rate does not reveal large regional disparities, and unemployment
remains highly concentrated among unskilled and older workers. Moreover, the
average duration of unemployment has been increasing, suggesting that the bulk of
unemployment is structural.
Despite successful growth, the growth of employment lagged. The labour force
declined by 2 per cent during the first 6 years of transition (1992-1997), while
employment declined by 5 per cent although real output increased by 21 per cent.
Also labour force participation rate declined, reflecting strong flows of the workingage population into nonparticipation. The structure of employment changed
significantly, reflecting the rigidities in the labour market legislation. Many older
workers retired in the early 1990s, some under company pressure and with the
encouragement of government-sponsored early retirement programs. The trend
toward a falling share of older workers was reversed by the pension reform, passed
in 1999 and implemented in 2000, which introduced (among other policy measures)
a gradual increase of the retirement age. Young workers faced more difficult access
to jobs because of the tight labour market; while on the other hand, the returns of
education increased dramatically, making university education more attractive.
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Major part of the inactive young cohort is in the education process. The number
of college students nearly tripled by the year 2002, which can be contributed to
significant increase of returns of education for all groups of educational attainment.
Table 4 reveals the distribution of after-tax income using the aggregation of
taxpayers into five categories regarding their education. The results clearly imply
correlation between the level of education and the level of income. More educated
taxpayers report substantially higher income; as the data show, the average annual
income of taxpayer with at least university education is 2.5 times higher compared
with the income of taxpayers with completed primary school or lower education
(16,792 EUR versus 6,476 EUR) (Table 3).
Also minimum wage legislation, where minimum wages were set at 48 per cent of
average wage in 2005 (very high by international standards), employment protection
legislation that imposes strict regulation on working time schedules and layoff
practices, high tax wedge and other structural reasons are further issues that cause
additional distortions. These problems resulted in low international competitiveness
of Slovenian labour market and significantly contributed to the low international
competitiveness of the whole economy.
The labour market is consequently one of the most problematic aspects of Slovene
competitiveness, besides the pension system, bureaucracy and governance quality,
which is confirmed also by the IMD (World Competitiveness Yearbook, 2006),
WEF (Global Competitiveness Report, 2005) and the World Bank’s Doing Business
study (2009). The reports stress especially the tax legislation (including high
personal taxes and social security payments) and labour market characteristics,
primarily restrictive labour market regulations, firing legislation, wage rigidities,
high tax rates and social security costs, problems with employing immigration
workers, employment of women in the private sector and inadequate education are
being mentioned as problematic.
4.2. The proposed labour market reform
Reform in the labour market has been a hot topic on the agenda of several
governments, but so far it has remained at the stage of proposals, because all
negotiations with the unions failed. Such a reform would be harmful mainly
to those less skilled, whose jobs would be more threatened due to economic
restructuring. The pressure from unions has been thus constantly strong and also
successful, because so far, except for some minor adjustments, no reform that would
significantly help reduce distortions in the labour market was passed. The reforms
mainly promote employment programmes, but do not tackle the main problem –
rigidity.
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The newly elected right oriented government, which came to power in 2004,
had a very ambitious general economic reform plan that was aimed at increasing
competitiveness of the economy (Government Office for Growth of the Republic
of Slovenia, 2005). One of the important aspects of the reform programme was also
labour market reform.
The labour market reform proposal consisted of six major measure packages all
aimed at increasing the efficiency of the labour market. Increasing the flexibility of
the labour market was one of the primary concerns of the reform suggestion. High
firing costs are the primary reason for the reluctance of employers to give workers
permanent contracts. Instead the firms protect themselves against high firing costs
with contracts for a specified period of time. To do that lowering firing costs were
suggested, shorter firing notice, maximum severance costs, for both workers and
managers. The reform also suggested introducing flexi-time work options, job
sharing, work from home, which would all also help at least partially to solve the
problem of population ageing and increase the employment options of women and
also reduce their discrimination in the labour market.
The proposed change in the salary system in the private and public sector was aimed
at increasing the flexibility of the wage system, determined by collective bargaining,
to allow for a more stimulating wage system, especially for those with higher
education and hence higher productivity. The proposal also suggested that workers
would be able to participate on profit sharing, if so was decided in firms. To achieve
that, several measures were proposed. First, the industry collective bargaining
would have a less important role; it would only determine minimum wages, while
actual wages would be determined directly in bargaining on firm level. A wage
reform in the public sector was suggested, aimed at decreasing fiscal pressures and
realigning some anomalies in the wages in public sector. The reform also proposed
that wage growth should be related to productivity growth not to threaten long term
performance of firms and at the same time to ensure that workers also capture the
benefits of increasing wealth.
The reform proposal also focused on the reform of the tax system by decreasing
the tax burden and simplifying the administrative procedures. Among the different
proposals, a flat-tax system (similar to the Slovak one with a single (and same) tax
rate for personal income tax (PIT), capital income tax (CIT) and value added tax
(VAT)) divided the public opinion and was later rejected in particular by labour
union. The finally adopted tax reform, effective from January 2007, includes new
PIT and CIT codes, new tax procedure rules, the gradual abolition of payroll tax
and several changes to less important taxes, e.g. the inheritance tax. Among the
major changes of the PIT and CIT codes one should emphasize the reduction of the
highest marginal PIT rate from 50% to 41%, schedular 20% taxation of interest,
dividends and capital gains, and the reduction of statutory CIT rate from 25% to
20%. In comparison with several CEE countries that decided in favour of more
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71
radical approaches, Slovenia once again decided on a more gradual approach. But,
as Majcen et al. (2009) show, the consequences of the reform are relatively modest
and give benefits to practically all taxpayers, while they harm the government
budget in the short run. The outcome of the initially very ambitious reform package
was thus finally quite modest, because the government gave in to the pressures of
the unions and the negative campaign in the media.
Despite the ambitious plans in the field of labour market changes and tax system
changes, only minor changes were implemented, primarily in the tax system. We
show that even these implemented reforms in general were not damaging to the
welfare of the ‘popular vote’, indicating the power of the negative public image of
the reform.
4.3. Why is the reform being delayed?
Since the beginning of transition the changes in labour regulations and wage
system were subject to collective bargaining. In August 1990, a general collective
agreement between the Chamber of Commerce and the Trade Union Organization
was signed. In this agreement, the initial wages for each category of workers were
set, supplemented by industry-specific agreements that effectively converted initial
wages into minimum wages at the level of industries. At the level of each firm, the
union and management bargained in the context of the firm’s annual plan to further
adjust industry level wages. The multi-layer bargaining structure resulted in both
wage dispersion and rapid wage growth.
As tripartite negotiations between unions, government and employer associations
might be justified with social consensus and were used to implement basic reforms at
the beginning of transition, national wage bargaining in the later stages of transition
were questionable and led to pervasive effects. Several studies on wage systems in
firms reveal that almost all firms kept the traditional, fixed pay system with a very
low variable part (Prašnikar et al., 2000; Domadenik et al., 2008) Moreover, a fixed
part of wage in the total wage bill increased during transition.
After almost 20 years of transition, it became evident that a deep microeconomic
reform of the labour market is needed. Government, Chambers of Commerce and
Union representatives sat down and tried to agree on new Labour Code that was in
power since 1993 and has many elements not familiar to a market economy. After
tough discussion they agreed to a few minor changes, mostly being associated with
layoff conditions. Although employers warned the government and employees that
the changes are not too profound, the union leaders were too strong. A new Labour
Code became effective in January 1, 2003. It seemed that the majority of people,
the voters, were disappointed by the negotiations and voted for the new government
that offered deeper solutions in its election campaign.
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After 2004, the new government started with a more liberal approach to institutional
organization, proposing a program of deep reforms, whose final goal was to increase
international competitiveness of the economy. Initially, flashy promises gained the
government wide public support, close to 70% (see Figure 2). In December 2004
the government established the strategic council for development. As intensive
public debate over reform characteristics started, the reform package started taking
shape and its liberal character was becoming more and more apparent. Public
support to government dropped to around 60%. The core of the reform proposal
was a flat tax rate and a labour market reform. The proposal led to a big campaign
against reforms, publishing TV and newspaper ads, organizing several events and
eventually in November 2004 unions gathered more than 20,000 people to protest
against the reforms due to the fear of loss of social security and the desire to retain
the workers’ rights at the existing level. Unions demonstrate their negotiating power
against government and employers’ organizations in this manner. It was successful.
Public support to the government plummeted to only 45% in November 2005 (see
Figure 2). The union pressure and negative public image of the reform process
continued. Quite successfully, if the unions were asked.
The labour market reform has (so far, by the end of 2008 and the end of office for
the government elected in 2004) not been implemented. This does not mean that no
results were achieved. The Minister of Labour resigned and new came to power.
She is praised by the unions for her understanding approach.
Out of the ambitious reform plan, the only more significant change was the income
tax reform, implemented in 2007. This reform will also have some, though partial
and limited effects on the labour market categories, such as the labour supply, real
wages and unemployment rates. But, the reform package was far from the initially
planned drastic reform. The data, based on the simulation results of Bayar et al.
(2006), reveals that the government gave in to the pressures of unions and that the
actually implemented reform. Despite obvious positive effects of the reform in
terms of employment growth, the obvious result is also that the income position of
the major voting groups improves.
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Figure 2: Public opinion poll: Do you support the policy choices of the government?
Source: Ninamedia (2007)
74
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4.4. Simulation of the tax reform and its impact on wages and employment
The theoretical model argued that the (un)popularity of a reform package might
be the main obstacle to its implementation, given that any government strives to
remain in position after the oncoming election. Public poles data revealed that the
popularity of the government fell dramatically when the ambitious reform plan was
presented. After long and scrutinizing public debate, the biggest reform was the
tax system reform, which also had some labour market implications. However, as
revealed shortly, the results of the simulations show that one of the key results will
also be the improvement of the income position for the majority of people. The
political acceptability of the reform was the priority over its economic dimensions.
In order to demonstrate this issue, the elements of our theoretical model, presented
in Section 3, were then implemented in a dynamic general equilibrium model of
the Slovenian economy (Bayar et al., 2006), linked to a microsimulation model
(Majcen et al., 2007). The resulting modelling framework, entitled SloMod, takes
into account the structure and all the fundamental mechanisms of the Slovenian
economy, as well as all the important elements of the structural and tax reforms,
including the reform of social transfers, changes of the government expenditures,
and the volume and structure of financial flows between the Slovenian and EU
budgets. All economic agents, i.e. households, firms, government and the foreign
sector, are assumed to adopt an optimizing behaviour under relevant budget
constraints. The difference between the theoretical and the empirical model is in
the level of detail, where the latter, built within the general algebraic modelling
system (GAMS) and solved numerically with the PATH algorithm, enables the
implementation of much richer economic structure.
Namely, in SloMod labour is differentiated according to the level of education
in three skill groups; unskilled labour, skilled labour and highly skilled labour.
Substitution possibilities between labour by skill type are reflected by a CES
function. Labour market by skill type is closed by changes in unemployment, thus
introducing rigidities. The responsiveness of real wage rates to the labour market
conditions is modelled by a wage curve, while the behaviour of labour supply is
determined through a labour supply curve. Wage differentials of the wage curve are
derived as the ratio between the wage rate by sector and skill and the average wage
rate by skill level, while the labour supply curve assumes a positive correlation
between the domestic labour supply and the real average net wage rate. Taxes are
also modelled in much detail, where we take into account the existing and proposed
PIT, CIT, VAT and social security codes, with associated allowances, standardized
costs and exceptions. Modelling of the government is in accordance with the
existing and projected budget data.
Having this in mind, the data in Table 3 reveals that the government actually gave in
to the pressures of the public opinion and passed a very populistic reform. Namely,
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the 2007 PIT reform obviously improved the income position of the majority of
taxpayers. Although the changes in absolute values were higher in higher income
brackets, the income did increase, which was a favourable result. Also, the feared
increase of labour market flexibility proved to be exaggerated, as changes to the
legislation were only marginal. Therefore, the main result of the reform was an
increase in income with little other change. A very populistic result.
Table 3: Distribution of average after-tax income, by education (in EUR in 2004
prices)
Education
Primary school or less
Lover cycle secondary school
Upper cycle secondary school
Non-university higher education
University education or more
Share of
taxpayers
15.6%
23.0%
33.2%
8.8%
12.4%
After-tax income
(2006 PIT Code)
6,410
7,247
9,105
12,653
16,375
After-tax income
(2007 PIT Code)
6,476
7,348
9,311
13,001
16,792
I2007/2006
101.0
101.4
102.3
102.8
102.5
Source: Authors’ simulations with the microsimulation model
As a results, the inequality increased, but the differences caused were not publicized
enough to be widely perceived by the public as negative. From the social point of
view, the adopted PIT and CIT codes seemed to be the most acceptable, with the
present value of welfare changes for individual scenarios of 72.6 million EUR (see
Table 5). On the other hand, all of the proposed scenarios would increase income
inequality in Slovenian society to a greater or lesser degree, including the finally
adopted PIT and CIT codes. However, according to the Gini coefficient, the Atkinson
index, and the squared coefficient of variation, this increase is the smallest in case
of the 2007 PIT and CIT codes. The values of the income inequality measures and
their respective changes can be observed in Table 4.
Table 4: Projected welfare variation measure and income inequality measures,
based on household equivalent disposable income (household level)
Measure
Present value of welfare changes
Index (REF = 100)
Gini coefficient
Index (REF = 100)
Atkinson index
Index (REF = 100)
Squared coefficient of variation
Index (REF = 100)
2006 PIT Code
68,887
0.2730
0.2523
0.3024
Source: Authors’ simulations with SloMod and the microsimulation model
2007 PIT Code
72,571
105.3
0.2785
102.0
0.2594
102.8
0.3210
106.2
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By implementing the 2007 PIT and CIT codes, total employment is projected to
increase due to the strong expansion of the private sector and increasing labour
supply. The total labour supply is expected to increase by 1.4% in 2013 and by
2.5% in 2025 as a consequence of real wages’ growth (see Table 6). The increase
in the labour supply of highly skilled people would be particularly strong (2.2%
in 2013 and 3.8% in 2025). Employment increase is significant in manufacturing
(more than 10% in 2013 and almost 20% in 2025 in some sectors) and services (cf.
Majcen et al., 2009). The expansion in the high technology sectors is especially
vigorous (13% in 2013 and 16.1% in 2025). Employment increase compared to the
baseline case is evident even in agriculture (2.9% in 2013 and 5.6% in 2025).
Table 5: Projected labour market effects of the 2007 tax reform
Labour market category
Unemployment rate, all skills (in per cent)
Unemployment rate, unskilled (in per cent)
Unemployment rate, skilled (in per cent)
Unemployment rate, highly skilled (in per cent)
Number of unemployed, total
Labour supply, total
(% change in comparison to baseline scenario)
Labour supply, unskilled
(% change in comparison to baseline scenario)
Labour supply, skilled
(% change in comparison to baseline scenario)
Labour supply, highly skilled
(% change in comparison to baseline scenario)
Real wage growth rate, unskilled (in per cent)
Real wage growth rate, skilled (in per cent)
Real wage growth rate, highly skilled (in per cent)
Source: Authors’ simulations with SloMod
Year
2013
2020
2025
2013
2020
2025
2013
2020
2025
2013
2020
2025
2013
2020
2025
2013
2020
2025
2013
2020
2025
2013
2020
2025
2013
2020
2025
2007–2013
2007–2013
2007–2013
2006 PIT
Code
5.41
3.86
3.23
12.00
9.53
8.40
4.56
2.96
2.34
0.79
0.40
0.28
66,177
62,522
63,900
1.42
2.09
2.45
0.80
1.15
1.34
1.37
2.03
2.39
2.24
3.29
3.83
0.62
0.97
1.58
2007 PIT
Code
5.55
3.97
3.33
12.24
9.76
8.62
4.69
3.06
2.42
0.84
0.43
0.30
67,947
64,410
65,883
1.63
2.29
2.64
0.88
1.22
1.41
1.58
2.23
2.59
2.59
3.62
4.16
0.61
0.95
1.53
I2007/2006
102.6
102.8
103.1
102.0
102.4
102.6
102.9
103.4
103.4
106.3
107.5
107.1
102.7
103.0
103.1
114.8
109.6
107.8
110.0
106.1
105.2
115.3
109.9
108.4
115.6
110.0
108.6
98.4
97.9
96.8
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77
As a consequence of significant job creation, unemployment would decline (see
Table 5). The overall unemployment rate would decline from 10.7% in 2004 to
5.4% in 2013, and to only 3.2% in 2025. The unemployment rate among unskilled
workers (i.e. with completed elementary school) would more than halve, declining
from 19.8% in 2004 to 8.4% in 2025. Among skilled and highly skilled workers, the
decline in the unemployment rate would be even more impressive: among skilled
workers, the unemployment rate would fall from almost 10% in 2004 to 4.6%
in 2013 and to 2.3% in 2025; among highly skilled workers, it would be almost
completely eliminated (decrease from 3% in 2004 to only 0.3% in 2025).
Productivity growth, increased labour demand, and a significant decline in the
unemployment rate should result in higher real wages and higher real income. The
increase is particularly strong for highly skilled workers and amounts to 1.6% per
year on average by 2013 (see Table 5). It is also strong for skilled workers (1.0%
per year on average). The increase in real household income with respect to the
baseline case (between 9.6% for the first quintile and 15% for the fifth quintile in
2013, and respectively 19.8% and 27.4% in 2025) should produce a significant boost
in private consumption (around 20% for all the categories in 2025) and savings.
Savings would increase given higher real return on capital.
5. Conclusion
Theoretical and empirical research confirms that a more flexible labour market is not
a threat to employment and social security but actually in the longer run increases
the dynamics of job creation. After all, employment is the best system of social
security. The actual victims of rigid labour market institutions are unemployed
workers and more productive employees while the so-called “lost generation”
(the less productive workers) who are supposed to be laid off, support stringent
regulation and are the main receivers of monopolistic rents. Therefore, despite being
aimed at protecting the labour force, rigid labour legislation has many negative
macroeconomic and microeconomic consequences.
Despite the obvious need for changes towards increasing the flexibility of the
labour market, the changes are often slow and delayed for as long as possible.
Due to pressure from both the unions, supporting usually the “lost generation”,
and the media, emphasizing mainly the potential negative impacts of the reform,
especially the loss of social security, the politicians usually give in to the pressures
due to the fear of losing office in the next election. Thus often the actual reform is
being discussed for a decade before a more significant step is made. And often it
is ultimately the high unemployment and other economic problems that force the
government into the decision to reform, not the actual desire and understanding of
all involved parties that reform has been necessary for quite some time.
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In the paper we test the hypothesis that in the context of political power theory the
reforms’ implementation depends on the opinions of low productivity workers about
potential benefits of the reform. The majority of proposed labour market reforms
were not implemented due to huge resistance of mostly low-income citizens. Tax
reform introducing new PIT and CIT codes was implemented mostly due to its
clear positive effect on increasing net income of all taxpayers. Therefore we found
theoretical and empirical support for our hypothesis.
Our research gives a new theoretical and empirical evidence of political power
implications when implementing labour market reforms. However, the model is for
now quite simple and apart from media doesn’t include labour unions as important
factor that affect general opinions of especially less educated people. Political
power theory will in the next stages of research have to be augmented by bargaining
models between different parties. Empirical evidence shows that those models are
very appropriate especially when speaking about former socialist economies like
Slovenia.
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Reforme na tržištu rada u kontekstu teorije političkih procesa:
Analiza Slovenije
Mitja Čok1, Polona Domadenik2, Tjaša Redek3, Miroslav Verbič4
Sažetak
Rigidnost na tržištu rada ima nekoliko negativnih ekonomskih posljedica: zazire
od otvaranja novih radnih mjesta, povećava diskriminaciju onih koje želi zaštititi
(mlade, stare i žene), pogađa nezaposlene, usporava restrukturiranje gospodarstva
i ima negativno djelovanje na konkurentnost globalnog gospodarstva. Unatoč
tome, reforme su spore i primjenjuju se uz mnoštvo polemika među partnerima.
Sindikati se protive reformama, jer se boje gubitka socijalne sigurnosti, a vlade
popuštaju pritiscima sindikata i medija zbog bojazni da bi im preoštre reforme
smanjile broj glasova na predstojećim izborima i time uništile politički položaj.
Članak analizira proces reformi u kontekstu analize teorije pogađanja između centara moći u teoretskom modelu i empirijskom na primjeru Slovenije.
Ključne riječi: fleksibilnost na tržištu rada, reforme, Slovenija, politički proces izbora
JEL klasifikacija: C70, D02, J08
1
2
3
4
Docent, Sveučilište u Ljubljani, Ekonomski fakultet, Kardeljeva ploščad 17, 1000 Ljubljana,
Slovenija. Znanstveni interes: porezni sustavi, fiskalna politika, financije. Tel.: +386 (1) 5892741. E-mail: [email protected].
Docent, Sveučilište u Ljubljani, Ekonomski fakultet, Kardeljeva ploščad 17, 1000 Ljubljana,
Slovenija. Znanstveni interes: mikroekonomska teorija, tranzicija, ekonomska analiza klimatskih
promjena i ekonomika rada. Tel.: +386 (1) 5892-498. E-mail: [email protected].
Docent, Sveučilište u Ljubljani, Ekonomski fakultet, Kardeljeva ploščad 17, 1000 Ljubljana, Slovenija. Znanstveni interes: makroekonomska teorija, teorija rasta i razvoja, analiza klimatskih
promjena, i institucionalna ekonomija unutar teorije rasta. Tel.: +386 (1) 5892-488. E-mail:
[email protected] (kontakt osoba).
Istraživač, Institut za ekonomska istraživanja, Kardeljeva ploščad 17, 1109 Ljubljana, Slovenija. Znanstveni interes: porezni sustavi, fiskalna politika, monetarna ekonomija, ekonometrija.
Tel.: +386 1 530-3842. E-mail: [email protected].